With Congress back in session following its winter recess, we expect an increasing focus on crypto-asset businesses, especially stablecoins, which are digital assets that are pegged to real assets — usually the U.S. dollar.
Stablecoins have experienced incredible growth and expansion recently. The aggregate stablecoin supply grew by 388% in 2021, from $29 billion to over $140 billion, a record high.[1]
In response, last year, the House Financial Services Committee[2] and the Senate Banking, Housing and Urban Affairs Committee[3] held hearings regarding stablecoins and other crypto-assets. And Sen. Sherrod Brown, D-Ohio, the chairman of the banking committee, sent oversight letters to stablecoin issuers and exchanges.[4]
Given many Democrats’ concerns about crypto-assets, we expect further congressional investigations in addition to Brown’s letter.
At the same time, potential stablecoin legislation is in the early stages of development, and both parties seem to support at least some legislative activity to supplement past actions taken by the federal financial regulators.
Sen. Pat Toomey, R-Pa., the ranking member of the Senate banking committee, recently proposed a framework for potential stablecoin legislation.[5]
Even in the face of a polarized political environment and the impending midterm elections, the stablecoin industry should be prepared for greater focus and attention from Congress in 2022 and beyond.
Regulatory Developments
The recent activity on Capitol Hill has come as federal financial regulators, particularly the U.S. Securities and Exchange Commission, have trained their sights on the crypto-asset industry.
SEC Chair Gary Gensler, like his predecessor Jay Clayton, has taken the view that many digital assets are considered investment contracts, and therefore subject to SEC regulation.[6]
In past public remarks, Gensler has advocated for more stringent regulation of stablecoins, comparing them to “poker chips at the casino”[7] and describing the crypto-asset industry in general as a Wild West.[8]
In recent years, the SEC has taken several enforcement actions against unregistered crypto-asset firms, including issuers and trading platforms, resulting in what some critics have called regulation by enforcement.
In September 2021, the SEC reportedly issued a Wells notice to Coinbase Global Inc.[9] saying that the SEC staff intended to recommend that the agency take an enforcement action against the company over a lending program in connection with its USDC stablecoin.
We expect that the SEC’s regulatory and investigative scrutiny of stablecoins will only increase under Gensler.
Other financial regulators are also beginning to focus on the crypto industry. Stablecoin issuers and other crypto-asset firms are subject to varying degrees of regulation by the Federal Reserve Board, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, U.S. Commodity Futures Trading Commission and state regulators.
The Financial Crimes Enforcement Network may also promulgate additional regulations or take enforcement actions relating to stablecoins.
In November 2021, the Fed, OCC and FDIC issued a joint statement indicating that they aim to provide greater regulatory clarity with respect to crypto-assets in 2022.[10]
The same month, the OCC published a letter stating that banks must receive a written notification of the OCC’s nonobjection prior to engaging in certain crypto-asset activities.[11]
Relatedly, the Fed released a discussion paper this month that solicited public comment on whether it should issue a central bank digital currency, but did not favor a particular policy outcome.[12]
Amid calls for a more centralized approach, there are rumors that the White House plans to release an initial interagency strategy to coordinate crypto-asset regulation as soon as February.[13]
Late last year, the president’s Working Group on Financial Markets — an interagency working group reporting to the president and consisting of the secretary of the treasury, Fed chair, SEC chair and CFTC chair — released a report regarding stablecoins in coordination with the FDIC and OCC.[14]
The report proposed a variety of recommendations designed to address potential investor protections, systemic risk and other concerns.
Notably, the report recommended that Congress pass legislation requiring all stablecoin issuers to become insured depository institutions.
By overseeing the report’s publication, the Biden administration is placing public pressure on Congress to take further action to regulate stablecoins.
We expect collaboration between Congress and the Biden administration on formulating prospective stablecoin legislation and attempting to implement the working group’s recommendations.
Recent Congressional Hearings
In December, both the House Financial Services Committee and the Senate banking committee held hearings on crypto-assets, with the Senate committee hearing focusing specifically on stablecoins.
These hearings follow the passage of the Infrastructure Investment and Jobs Act in November 2021, which included a controversial provision increasing the tax reporting requirements for crypto-asset transactions.[15]
During the hearings, the Democrats on both committees generally expressed serious concerns about crypto-assets and support for comprehensive regulation, while Republicans were less skeptical and favored more limited regulation.
We expect that these hearings will inform any future legislative and congressional oversight efforts, especially with respect to the key topics outlined below.
Systemic Risk
Several Democrats — including Brown, House Financial Services Committee Chair Maxine Waters of California, Sen. Elizabeth Warren of Massachusetts, and Sen. Jon Tester of Montana — expressed concerns about the potential systemic risk that could arise from stablecoins and compared stablecoins to the financial markets prior to the 2008 financial crisis.
This suggests that future legislative proposals may focus on reducing perceived systemic risk arising from the stablecoin industry.
Conversely, ranking member Toomey and other Republicans emphasized that stablecoins are less volatile than other crypto-assets because stablecoins are backed by real assets. Others noted that most stablecoins are fully reserved.
Investor Protection
Many Democrats, including Brown and Waters, had strong concerns that crypto-asset products do not involve sufficient protections for investors.
Warren asserted that stablecoins “have no regulators, no independent auditors, no guarantors, nothing,” and are “propping up one of the shadiest parts of crypto world, the place where consumers are least protected from getting scammed.”
Accordingly, we expect that future legislative proposals may mandate additional investor protections in the stablecoin industry. Such proposals could also encourage regulators, especially the SEC, to use their existing authorities to further regulate the industry, including through additional disclosure or auditing requirements.
Financial Inclusion
Crypto-asset proponents discussed how crypto-assets, including stablecoins, could promote financial inclusion by providing an alternative to the traditional payment system, which often involves hefty fees and processing delays.
Brown questioned these claims, asserting that many cryptocurrencies’ high volatility and transaction fees make them useless for payments. Republicans, on the other hand, generally seemed receptive to the argument.
We anticipate that this will be a fault line between the parties as legislative proposals develop.
Bank Secrecy Act/Anti-Money Laundering
During the House Financial Services hearing, several members of both parties were concerned about bad actors’ general use of crypto-assets.
Particular examples included ransomware actors demanding payment in crypto-assets and rogue states using crypto-assets to evade sanctions.
The hearing suggests that there may be bipartisan support for BSA/AML legislation affecting crypto-asset firms, including stablecoin firms, and Congress may conduct further oversight and investigations in this area.
Cybersecurity
Rep. Carolyn Maloney, D-N.Y., inquired about cybersecurity protocols, as well as processes for reimbursement if customer assets are stolen by hackers, citing the early 2021 Coinbase breach that reportedly impacted at least 6,000 customers.
This is another potential area for common ground between the parties.
Environmental Costs
Rep. Rashida Tlaib, D-Mich., asked about the environmental costs of crypto-asset mining, which consumes significant amounts of energy.
This month, the House Committee on Energy and Commerce held a separate hearing on this topic.[16]
Potential Legislation
Both hearings showed a substantial ideological divide between the Democrats and Republicans, although there were some modest areas of agreement.
We therefore expect that, if legislation related to crypto-assets were to be passed, it would be relatively narrow and focus on less controversial issues.
The hearings suggested that some potential areas for agreement include BSA/AML, consumer data security and privacy, consumer protection, safety and soundness, operational risks relating to the transfer of stablecoin on the blockchain, and gaps in platform regulation.
In November 2021, as an alternative to the recommendations from the president’s working group and the SEC’s enforcement approach, Toomey released a proposal in which stablecoin issuers could choose from one of the following three regulatory options:
- “Operat[ing] under a conventional bank charter”;
- “Acquir[ing] a special-purpose banking charter designed for stablecoin providers in accordance with new legislation” to be proposed later; or
- “Register[ing] as a money transmitter under the existing state regime and as a money services business under FinCEN’s federal regime.”[17]
Depository institutions that are not insured would be permitted to issue stablecoins if they complied with any one of those three regulatory frameworks, and stablecoins that don’t bear interest would not always be considered securities for regulatory purposes.
Toomey also suggested requirements relating to redemptions, disclosure, customer privacy and BSA-AML.
We do not expect Toomey’s framework to be adopted as currently written, but it will likely serve as a starting point in negotiations between the two sides if, as seems reasonably likely, the Senate banking committee pursues legislation of the stablecoin industry.
Sen. Steve Daines, R-Mont., said during the banking committee hearing that he believed a bipartisan legislative framework for stablecoins was possible and necessary.
Ultimately, Congress may find legislating on stablecoins to be as difficult as updating and modernizing other laws related to advancing technologies, such as the Communications Decency Act or the Stored Communications Act.
Congressional Inquiries and Investigations
While bipartisan legislation on stablecoins appears to be aspirational for now, Congress may find greater oversight and investigations to be a more productive outlet for their concerns.
On Nov. 23, 2021, Brown sent letters requesting information to eight stablecoin issuers and exchanges about their processes and policies, focusing on investor protection issues.[18]
Brown briefly mentioned this letter at the banking committee hearing, stating that the responses “were not very enlightening — and should lead us to assume most ordinary customers don’t have much in the way of rights at all.” He did not otherwise engage, however, on the substance of the responses during the hearing.
In light of the remarks made by Brown, Waters and others at the recent hearings, we expect Brown’s letter to be the first of many congressional oversight actions. Indeed, on Jan. 24, House Financial Services Committee ranking member Patrick McHenry, R-N.C., sent a letter to Waters specifically requesting more hearings and congressional action to prevent perceived overreach by federal regulators.[19]
The banking committee and financial services committee could take several follow-up actions, such as holding additional hearings, sending additional requests for information, conducting interviews or depositions, writing a report or reports, and referring individual matters to the executive branch for civil enforcement or criminal prosecution.
Key Takeaway
We recommend that crypto-asset businesses, especially stablecoins, continue to monitor congressional developments.
Given both parties’ interest in crypto-assets, we expect that new legislative proposals, as well as further congressional inquiries and oversight action, will continue to affect this rapidly developing and expanding industry.
***
To subscribe to the Debevoise Fintech Blog, click here.
***
[1] “2022 Digital Asset Outlook,” The Block (Dec. 2022), available at https://www.tbstat.com/wp/uploads/2021/12/The-Block-Research-2022-Digital-Asset-Outlook.v2.pdf.
[2] Hearing, “Digital Assets and the Future of Finance: Understanding the Challenges and Benefits of Financial Innovation in the United States,” U.S. House Committee on Financial Services (HFS) (Dec. 08, 2021), available at https://financialservices.house.gov/events/eventsingle.aspx?EventID=408705.
[3] Hearing, “Stablecoins: How Do They Work, How Are They Used, and What Are Their Risks?”, U.S. Senate Committee on Banking, Housing, and Urban Affairs (SBC) (Dec. 14, 2021), available at https://www.banking.senate.gov/hearings/stablecoins-how-do-they-work-how-are-they-used-and-what-are-their-risks.
[4] Majority Press Release, “Brown Presses Stablecoin Companies on Risks” SBC (Nov. 23, 2021), available at https://www.brown.senate.gov/newsroom/press/release/brown-stablecoin-companies.
[5] Minority Press Release, “Toomey Outlines Stablecoin Principles to Guide Future Legislation,” SBC (Dec.14, 2021), available at https://www.banking.senate.gov/newsroom/minority/toomey-outlines-stablecoin-principles-to-guide-future-legislation.
[6] Gary Gensler, “Remarks Before the Aspen Security Forum,” U.S. Securities and Exchange Commission (SEC) (Aug. 03, 2021), available at https://www.sec.gov/news/public-statement/gensler-aspen-security-forum-2021-08-03.
[7] Tory Newmyer, “SEC’s Gensler likens stablecoins to ‘poker chips’ amid call for tougher crypto regulation,” The Washington Post (Sep. 21, 2021), https://www.washingtonpost.com/business/2021/09/21/sec-gensler-crypto-stablecoins/.
[8] Gensler, supra note 6.
[9] Olga Kharif and Joanna Ossinger, “Coinbase Gets Wells Notice From the SEC on Lend Product,” Bloomberg (Sep. 07, 2021), available at https://www.bloomberg.com/news/articles/2021-09-08/coinbase-gets-wells-notice-from-the-sec-on-its-lend-product.
[10] Statement, “Joint Statement on Crypto-Asset Policy Sprint Initiative and Next Steps,” Board of Governors of the Federal Reserve System (FRB), Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) (Nov. 23, 2021), available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20211123a1.pdf.
[11] Press Release, “OCC Clarifies Bank Authority to Engage in Certain Cryptocurrency Activities and Authority of OCC to Charter National Trust Banks,” OCC (Nov. 23, 2021), available at https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-121.html.
[12] Press Release, “Federal Reserve Board releases discussion paper that examines pros and cons of a potential U.S. central bank digital currency (CBDC),” FRB (Jan. 20, 2022), available at https://www.federalreserve.gov/newsevents/pressreleases/other20220120a.htm.
[13] Jennifer Epstein, Jenny Leonard, and Allyson Versprille, “White House Is Set to Put Itself at Center of U.S. Crypto Policy,” Bloomberg Government (Jan. 21, 2022), available at https://www.bgov.com/core/news_articles/R62HH0DWLU6O.
[14] Press Release, “President’s Working Group on Financial Markets Releases Report and Recommendations on Stablecoins,” U.S. Department of the Treasury (Treasury) (Nov. 01, 2021), available at https://home.treasury.gov/news/press-releases/jy0454.
[15] Specifically, the law requires crypto-asset brokers to record transactions and disclose customer names, addresses, and phone numbers; proceeds from sales; and capital gains or losses, among other requirements. See Laura Davison, “How Taxing Crypto Got Changed by Biden’s Infrastructure Law,” Bloomberg (Nov. 17, 2021), available at https://www.bloomberg.com/news/articles/2021-11-17/how-taxing-crypto-got-changed-by-infrastructure-law-quicktake.
[16] Hearing, “Cleaning Up Cryptocurrency: The Energy Impacts of Blockchains,” U.S. House Committee on Energy and Commerce (Jan. 20, 2022), available at https://energycommerce.house.gov/committee-activity/hearings/hearing-on-cleaning-up-cryptocurrency-the-energy-impacts-of-blockchains.
[17] Minority Press Release, supra note 5.
[18] Majority Press Release, supra note 4.
[19] Minority Press Release, “McHenry to Waters: We Must Work Together to Create Opportunities that Allow Digital Assets to Flourish,” HSFC (Jan. 24, 2022), available at https://republicans-financialservices.house.gov/news/documentsingle.aspx?DocumentID=408235.
***
See original article at Law360, available here.
